Stock-Option Backdating Scandal Expands

Although not illegal, the accounting associated with executive stock option backdating “doesn’t feel right,” according to The CorporateCounsel.net. One company, UnitedHealth Group, may end up restating three years of financial results due to option back-dating. This accounting adjustment will see a change of some $286 million in net income for the company.

UnitedHealth Group’s disclosure reads, “The results of the review to date indicate that the company may be required to record adjustments to non-cash charges for stock-based compensation,” according to the Associated Press.

So-called “old” accounting rules state that options have no value if their exercise price is the same as the current share price. The Associated Press reports that if the exercise price is set below the current price of shares, an option share would have an intrinsic value amounting to the difference between the exercise and market prices that would, in turn, be expensed against reported profits. Companies have fought changing this rule tooth and nail.

The Securities and Exchange Commission (SEC) is investigating several companies, including UnitedHealth Group, for back-dating options in order to increase their value to executives and not recording a corresponding cost to earnings. It seems that executives were also allowed to select dates in the past where the market price of the stock was lower and that price became the exercise price of their option shares. This is not illegal, according to the Associated Press.

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In order to avoid expensing the intrinsic value of the options to earnings, the exercise date was carried over with the exercise price and called the “grant date”, allowing the grant to “occur” in the past as well, according to the Associated Press. Any definition seems to clash at this point, as literally, the grant date is the day on which you decide the exercise price of an option. It’s supposed to be a real date instead of a reference point in a date calculation.

This is also a clash of rules-based accounting vs. principles-based accounting. The Associated Press reports that the precise concept of the term “grant date” is not specifically defined under rules-based accounting, allowing for different interpretations, while in the realm of principles-based accounting, the grant date is one specific date.

In addition to UnitedHealth Group, Juniper and F5 Networks have apparently been repricing options over seven years at the stocks’ monthly lows, according to TheStreet.com. Market patterns suggest company executives’ were the beneficiaries of this backdating. Their options were maximized in the process.

Back in mid-April, UnitedHealth Group CEO Bill McGuire announced that he would volunteer to forego his millions in option grants, seeking a settlement with the SEC. Their investigation has lead in the same direction as with Juniper and F5 Networks, according to the Minneapolis-St. Paul Star Tribune. He has had $100 million cash-and-stock paydays in the past, and the value of his remaining options amounts to some $1.6 billion. Such gracious compensation has been defended, using the excellent performance of the large medical insurer’s stock. The SEC and the Minnesota attorney general are, nevertheless, looking into whether McGuire or his board violated any laws.

“UnitedHealth Group’s CEO serves as a good example of excessive CEO pay being the fault of an aggressive CEO and a compliant board, which impacted the pay structure of an entire industry,” said Broc Romanek, former SEC attorney and corporate counsel, speaking with the Minneapolis-St. Paul Star Tribune.

Romanek told the Minneapolis-St. Paul Star Tribune, “My thoughts relate more to UnitedHealth Group’s pay in general, rather than on the backdating issues, which are hard to parse due to ambiguous legal standards.” Romanek is also editor of The CorporateCounsel.net and CompensationStandards.com.

Brother Louis DeThomasis is chancellor of St. Mary’s University, a one-time entrepreneur and current lecturer on business ethics. He told the Minneapolis-St. Paul Star Tribune, “Even if there’s nothing illegal at United, this is the extreme of obscenity in corporate governance. We must reward excellence in performance. But handing people eternal paradise … $1.6 billion worth of options is a bit much.”